A Sanctions Primer: What Happens to the Targeted?

US and EU sanctions against Russian and Ukrainian officials were subjected to almost as much analysis in Russia as the annexation of Crimea itself. The discussion took place not only in diplomatic and financial circles and in the social media, but at most kitchen tables across the country because the sanctions affect ordinary Russian citizens as well as the higher-ups who were actually targeted.

A small case of mistaken identity tells why. At the beginning of April, just when the sanctions were going into effect, a Russian citizen named Sergei Ivanov, who worked for the free daily newspaper Metro, in St. Petersburg, ordered a new pair of sneakers from an American website. A short while later, Ivanov received a notice from the online store saying that his name was on the list of people forbidden to order from the US and his purchase was canceled. In Russia, Sergei Ivanov is as common as John Smith is in America. As it worked out, the Sergei trying to buy some sneakers had been confused with another much more powerful Sergei Ivanov: the Kremlin’s chief of staff.

The lesser Sergei found a way to have his shoes delivered. He reordered under another person’s name. In addition to sneakers, he got a letter from the greater Sergei, head of President Vladimir Putin’s administration, saying that he was surprised to know that US sanctions against him caused trouble to someone else, “but together we shall overcome all these hardships and your case was a good example for us on how we can avoid the most terrible American sanctions.”

When the US decides to sanction someone, his or her name goes onto the SDN (specially designated nationals) list at the US Department of the Treasury. Everyone can see the list online, and every bank and major corporate compliance department gets a copy of it. The moment that happens, any American company or bank doing business with the individual on the list is breaking the law and subject to a large fine. There is a huge public relations risk, as well as a huge financial incentive, for all American and European firms to avoid doing business with anyone on these sanctions lists.

“It’s not just every American firm,” explains Bill Browder, the CEO of Hermitage Capital, a global investment advisory firm. “It’s any company in the world that has an American subsidiary which is potentially at risk of violating US sanctions if they do business with someone on that list.” A person on the list becomes an international financial pariah. “No American firms and very few international firms will have anything to do with them because they don’t want to get into trouble with the US government,” explains Browder, who was instrumental in the passing by the US Congress of the Sergei Magnitsky Rule of Law Accountability Act, signed by President Obama in December 2012, which forbids Russian officials involved in corruption and human rights violations to enter the US and also freezes their assets.

After the annexation of Crimea, the blacklist of Russian officials became longer. Collaborating Ukrainian officials joined them there. All their names will automatically go into financial and commercial databases, such as World-Check, that banking institutions use to make sure they are not doing any business with targeted individuals.

Asset freezes work similarly. Transactions from banks outside the US and EU that require the use of dollars or euros must use what are known as correspondent accounts with banks in America or the eurozone, depending on the currency. A targeted individual with deposits in euros or dollars in a Russian bank who tries to pay his hotel bill or rent a car or send money in the US or somewhere in Europe will not be able to do so. The banks managing those correspondent accounts have received instructions from the authorities that the bank account holder is on the sanctions list and that his or her operation must be blocked. Even if an individual doesn’t have accounts abroad, he or she won’t be able to make transactions in international currencies.

Right after the “referendum” in Crimea, when the US imposed sanctions against Russian and Ukrainian officials and against one Russian bank, Rossiya, American credit card companies Visa and MasterCard stopped transactions not only for those who were sanctioned (Arkady Rotenberg and Boris Rotenberg, major shareholders of the bank and members of Putin’s inner circle), but other Russian clients of the bank as well. There was a sound of whistling in the graveyard when Putin declared that he would open his own account in a bank targeted by the US Treasury and that his salary would be paid on that account. Chechnya’s leader, Ramzan Kadyrov, did the same.

Clients of other banks, like SMP, Invest Capital, and Sobinbank were also impacted. In total, according to the Russian Central Bank, several hundred thousand people have suffered directly from the Visa and MasterCard decisions to stop providing services.

Sanctions could also potentially cost banks large numbers of customers due to limited financial services, including dealing only in rubles. Several days after sanctions were announced, Putin shrugged, “These measures will simply cause them to lose a segment of the market—a very profitable one.” Yet the flow of money out of Russia suggested that the opposite was true. In the first quarter of 2014, an estimated $50 billion left the country, according to the Russian Central Bank, and the minister of economic development suggested that by the end of the year it could surpass $100 billion. This outflow was the result not only of the sanctions, but also of the Kremlin’s economic and internal policy.

The Russian government’s response also contradicted Putin’s cavalier dismissal of sanctions. Authorities claimed that the country would develop its own credit card system, independent from that of Western companies. Putin ordered the Russian Central Bank to lend cash to private banks so they could continue to serve their clients. In effect, Russian taxpayers will therefore be supporting those who are on the sanctions list, as the “rescue” money will be coming directly from the federal budget. The costs are subtle but not insignificant. Car racing fans might have to switch to a different sport, as they will not be able to watch their favorite team competing in the most famous race in the world, the European Le Mans Series, or any of the World Endurance Championship races. SMP Racing, the company that supports the Russia team in these races, is owned by Boris Rotenberg, and all its European and American accounts have been frozen.

Do administrative barriers work? For the most part, individuals whose names are on the US list will probably be banned from other countries as well. Once a name has been added to the American list, it becomes difficult to obtain a visa for Europe, even for family members of the targeted person.

Every rule has exceptions, of course. Gennady Timchenko, for example, the main shareholder of the energy company Gunvor until he sold his shares just before becoming a sanctions target of the US State Department, had been invited to travel to Paris on April 24th to take part in a series of roundtables on Russia, although he decided at the last minute not to attend. He has Finnish citizenship, which gives him another escape route from EU sanctions, and he is connected to the top of Russian finance. US authorities believe that Putin is an investor in Gunvor and “may have access to Gunvor funds.”

Once on the list, however, most people will not only suffer travel restrictions, but their businesses will also come under surveillance by local authorities. For example, someone who has a company in Cyprus and wants to buy another firm under his or her name will likely find that the deal has been blocked.

As for the financial part, US banking institutions will ask targeted people to close their accounts or their assets will be frozen. Unless they want to conduct the operation in Chinese yuan, the road ahead for them will be difficult, and as long as money is frozen, it does not produce interest. US banks consider the sanction force majeure, and EU bankers will probably act in a similar fashion even if the named person is not officially on the EU list.

If someone on the sanctions list is also a shareholder of an American company, the board will have to be informed, and at the next board meeting, the company will have to freeze that person’s shares and state to the US authorities that one of the company’s shareholders is a person on the Office of Foreign Assets Control (OFAC) list.

The consequences of being on the sanctions list are not only financial. The damage to the reputation of someone on the list is enormous, and continues even after he or she has been removed. Very few banks will do business with someone whose name has been on the OFAC list. What’s more, relatives of that individual have to declare that they are related to a “politically exposed person” (PEP), a phrase usually describing someone potentially involved in bribery or corruption because of their position or influence. Banks and financial institutions are reluctant to deal with PEPs, and their relatives will be more closely watched. Banking institutions will continuously monitor the source of their income. For each investment, relatives of PEPs will have to justify the source of the funds and show it is not connected to targeted individuals.

Challenging sanctions is difficult if not impossible, as they are imposed by the foreign ministry or state department of a particular country against individuals that government merely declares to be dangerous, not necessarily with any proof. In theory a person targeted by the EU could try to challenge the sanctions before the European Court of Human Rights, in Strasbourg. But such sanctions are imposed by EU foreign ministries, and trying to challenge them would be like trying to challenge Interpol.

Governments are also not compelled to respond to appeals from targeted individuals regarding visa bans, but in the US financial sanctions can be challenged. “Even sanctions imposed by the president are subject to the Constitution,” explains Kyle Parker, a policy adviser with the US Helsinki Commission as well as an architect of the Magnitsky Act. “The underlying authority used for financial sanctions in peacetime is generally the International Emergency Economic Powers Act. This law provides substantial power to the executive branch, but we have checks and balances and so our courts seek to ensure that such power is wielded consistent with laws like the Administrative Procedure Act and, of course, the Constitution. For these reasons, the Department of Treasury is extremely careful in assembling evidentiary targeting packages, knowing that any designation can be subject to judicial review.” Parker adds, “It shouldn’t be easy to get sanctioned by the United States and we’d much rather perform the painstaking due diligence, taking our time, and even passing on names that seem obvious to many than risk having a designation overturned.”

After the mid-April Geneva meeting between Russian Foreign Minister Sergei Lavrov, EU chief diplomat Catherine Ashton, US Secretary of State John Kerry, and Ukrainian interim Foreign Minister Andriy Deshchytsia, everyone understood that Kremlin diplomacy had won once again. After Western countries considered that Moscow did not take any step to de-escalate violence in eastern Ukraine, the sanctions lists were expanded. The US list is more extensive than the EU’s, which has to get twenty-eight member states to agree, more than a few of whom fear that more-severe sanctions could trigger recession in the eurozone.

Laurent Fabius, the French foreign minister, declared in March, right after the “referendum” in Crimea, that France might suspend the contract for the sale of two Mistral-class helicopter carriers to Russia. But how would such a move affect France? The construction of the ships in the Saint-Nazaire shipyard has generated a thousand jobs. French trade unions are already agitating to protect them. What’s more, the cancelation of the contract and the failure of France to deliver the two ships would result in a loss of $1 billion. That’s the last thing President François Hollande wants to have to tell the French people at this point in his battered presidency. Ironically, the two boats are named Vladivostok and Sevastopol, the latter being the main harbor in Crimea used by the Russian fleet.

The foreign minister of Cyprus, Ioannis Kasoulides, declared in an interview to the German daily Die Welt, just before the Geneva meeting, that the Russian economy and the Cypriot economy were so tightly intertwined that the sanctions “will destroy” Cyprus’s economy faster than it will affect Russia. According to Kasoulides, each EU country needs the opportunity to choose whether or not it will introduce the sanctions. According to Finnish economists Paivi Karhunen and Svetlana Ledyaeva from Aalto University, in the last twenty years, the Russians have laundered $31 billion through Cypriot banks—“$12 billion from banks and $19 billion from businesses and individuals.” It is not surprising that Cyprus is reluctant to abandon its Russian connection.

Despite the EU and US sanctions, Russian officials on the sanctions list are still able to travel wherever they please around the world. In early April, Sergei Naryshkin, the speaker of the Russian State Duma, took part in UNESCO events in Paris. This was possible because UNESCO is an international organization with an accord de siège—a treaty with France dating back to 1954. According to this agreement, the UN group is independent; it has immunity on French territory and can invite whomever it wishes without possible interference from French police.

“In Belarus we had the same story,” explains Andrei Sannikov, a Belarusian politician, ex–political prisoner, and candidate in the 2010 presidential elections. “In 2009, the deputy head of [Aleksandr] Lukashenko’s administration, Natalya Petkevich, who was on the US sanctions list, nevertheless came to New York for the UN session. She was gloating she had defied the American administration. Petkevich then went shopping. When she got to the cash register to pay for her purchases she suddenly found out that her card had been rejected because her assets had been frozen.”

Sannikov said that some of the Belarusian officials who were blacklisted were trying to make a deal with the embassies, even paying off the embassies’ staff for visas or trying to get them through a travel agent. “The most crucial point is how the EU is implementing its visa ban policy,” he emphasized, noting that in 2002, President Lukashenko managed to enjoy a vacation in a ski resort in Austria with family and colleagues even though he was supposedly banned from traveling in the EU. To make it possible, he had asked for help from Leo Wallner, co-owner of Casinos Austria and then chairman of the Austrian National Olympic Committee. Several years later, investigators revealed that Lukashenko’s ski vacation had come at a cost of about 200,000 euros, which had been covered by Casinos Austria. Wallner was later himself the subject of a criminal investigation. However, there are signs that the sanctions might be starting to work. At the end of April, Bulgaria canceled Speaker Naryshkin’s visit to the country. OAO Rosneft, the Russian oil conglomerate, whose CEO, Igor Sechin, is on the US sanctions list, has seen its first-quarter income fall sixty-five percent. IT companies like Microsoft and HP plan to cease cooperation with Russian companies on the sanctions list. In Baikonur, the main hub of Russian spaceflight, several projects have been suspended because any satellite equipped with American electronics was forbidden to lift off on Russian launchers.

A highly placed European diplomat confided that a number of Russian officials are worried about a new package of sanctions and are calling European embassies to find out if their name will be added to the list. The official claim until now, that it is a badge of honor to be on that list, is starting to crumble—and fast. Even Vladimir Putin, during a three-and-a-half-hour appearance on Russian television, said the sanctions were a “human rights violation.” The Russian president was talking about people added to the sanctions list after the annexation of Crimea—people like his friend Gennady Timchenko, whose wife, after the sanctions, he said plaintively, “could not pay for her operation because her credit card was frozen.”

Putin should also be concerned about himself. According to the Times of London, the US government is contemplating adding his name to the list of targeted individuals and freezing his own fortune, often estimated at $40 billion, in Swiss banks, if he decides to invade eastern Ukraine. But Putin’s spokesperson, Dmitri Peskov, said that his boss had complete peace of mind about this possibility.

Elena Servettaz is a Russian-French journalist and newscaster at Radio France Internationale, in Paris, where she covers international affairs, corruption, and money laundering, as well as the editor of the 2013 book Why Europe Needs a Magnitsky Law.